Chapter 1 Business Combinations

1
Chapter 1 Business Combinations

• Accounting Standards
• ARB 40, Business Combinations
• ARB 48, Business Combinations
• APB Opinion 16, Business Combinations
• Restricted the application of Pooling of
  interests by requiring meeting 12 conditions( 2
  conditions for attributes of the Combining
  Companies, 7 conditions for agreement on how
  interests are to be combined and 3 conditions for
  absence of planned transactions)

2
Current Accounting Standard for Business
Combinations

• FASB Statement 141 (issued in 2002)
• Pooling of interests is prohibited
• All combinations must be accounted for by the
  purchase methods

3
Accounting for Goodwill

• FASB 142, Accounting for Intangible Assets
• Goodwill from business combinations will no
  longer be amortized, but subject to annual
  impairment test. If impaired, goodwill must be
  written down and charged off as a separate item
  in income statement as part of operating expenses

4
Goodwill impairment test

• Two-step impairment test shall be used to
  identify potential goodwill impairment and
  measure the amount of goodwill impairment loss to
  be recognized
• 1st step to identify potential impairment by
  comparing the fair value of a reporting unit with
  its carrying amount, including goodwill.
• 2nd step to measure the amount of impairment
  loss by comparing the implied fair value of
  reporting unit goodwill with the carrying amount
  of that goodwill.

5
Type of Business Combinations

• Statutory Merger
• Only the acquiring company survives the acquired
  company is dissolved.
• Statutory Consolidation
• New company is formed to take over
• Stock Acquisition
• One company acquires the voting shares of another
  company and the two companies continue to operate
  as a separate entities.

6
Recent Mergers and Acquisitions

• PG to acquire Gillette 55
  billion
• SBC to acquire ATT 16 billion
• Sprint to buy Nextel Communications 35
  billion
• Johnson Johnson to acquire Guidant 25
  billion
• Symantec to buy Veritas
  13.5 billion
• Oracle acquired PeopleSoft 10.5 billion
• J.P. Morgan Chase bought Bank One 60
  billion

7
Purchase Accounting

• Situation 1
• Purchase price is greater than the fair market
  value of the identifiable net assets acquired
• All assets and liabilities are recorded at the
  fair market value and goodwill is recorded
• Goodwill is the excess of purchase price over the
  fair market value of identifiable net assets

8
Purchase Accounting (continued)

• Situation 2
• Purchase price is less than the fair market value
  of identifiable net assets
• The negative goodwill is reduced from the
  non-priority assets and priority net asses are
  recorded at their fair market values.
• If all non-priority assets are reduced to zero,
  then the remaining amount is reported as an
  extraordinary gain to be reported in the period

9
Accounting for business combination expenses

• Direct acquisition costs (legal fees, finders
  fee, etc)---- As the direct acquisition costs
  to the price paid for the acquired company
• Indirect acquisition cost (allocated internal
  costs)--- Expensed when incurred
• Stock issuance cost--- Deduced from the value
  assigned to equity securities issued ( that is a
  reduction from APIC)

10
Recording a purchase

• (1) Investment in ABC Stock XXX
• Common stock XXX
• APIC XXX
• (2) Investment in ABC(direct cost) XX
• APIC (stock issuance costs) XX
• Cash
  XX

11
Recording purchase

• If the acquired company is dissolved
• Net assets (at fair market value) XXX
• Investment in ABC stock XXX

12
Contingent consideration in a purchase agreement

• Contingent consideration based on
  earnings------Treated as additional acquisition
  cost (normally, this will result in an increased
  amount of goodwill)
• Contingent consideration based on issuers
  security prices(The purchaser guarantee the total
  value of the securities on a given
  value)----Treated as a reduction from APIC

13
Disclosure Requirements

• The name and a brief description of the acquired
  company
• A statement that purchase treatment has been used
• Information on the total cost incurred in making
  the purchase
• The portion of the year for which operating
  results of the acquired company have been
  included
• Information on any contingent payment or
  commitments and their treatment

14
Example Case (a)

• 1. Investment in Sells Corp. 1,250,000
• Capital stock
  
  500,000
• Additional paid-in capital
  
  750,000
• 2. Investment in Sells Corp. 70,000
• Additional paid-in capital
  25,000
• Cash
  
  95,000

15
(continued)

• 3. Cash
  20,000
• Receivable
  70,000
• Inventory
  210,000
• P E
  600,000
• Land
  200,000
• Goodwill
  320,000
• Liabilities
  100,000
• Investment in Sells Corp.
  1,320,000

16
Case (b)

• 1. Investment in Sells Corp.
  750,000
• Capital stock
  
  500,000
• Additional paid-in capital
  250,000
• 2. Investment in Sells Corp.
  70,000
• Additional paid-in capital
  25,000
• Cash
  
  95,000

17
(continued)

• 3. Cash
  20,000
• Receivable
  70,000
• Inventory
  210,000
• P E (600,000-135,000) 465,000
• Land (200,000- 45,000) 155,000
• Liabilities
  100,000
• Investment in Sells Corp.
  820,000